I often ask my pre-retirement clients what their biggest assets are. My home, car, investment portfolio and business are all reasonable answers, but not the one I’m angling for. In many cases, a client’s largest asset is their ability to earn an income, particularly when they have a material number of working years left under their belts. But there is no guarantee that they will be physically and mentally capable of delivering the work they do today, tomorrow.
It’s in our nature to discount the value of an asset to be received at some time in the future; we value tangibility over intangibility. But your ability to earn an income, your human capital as it is known, while intangible, is a very real and weighty asset. Should it be taken from you due to poor health or injury, your financial security would face a substantial threat.
To understand just how important human capital is in the context of your estate, consider the following example. A 40-year-old, currently taking home R40,000 per month, plans to retire at the age of 65. Over that 25-year period, assuming her wage increases by inflation of 4.5% per annum, she will earn a total of R 21,391,300.87. Compare that figure to the other assets that such an individual is likely to own, and the importance of your human capital becomes clear.
We take out insurance on our houses and vehicles. We also fork out for medical aid and life insurance to cover the costs and consequences that come with medical bills and mortality respectively. Insuring for these worst case scenarios is widely accepted practice. And yet, the loss of your future income — which may be more financially ruinous — remains a somewhat second-tier form of insurance.
To paint the picture very clearly, losing your ability to earn an income would bring you face-to-face with the following realities, among others:
These ramifications would have a negative impact on your wellbeing, as well as that of your family. This at a time when you are already dealing with the emotional turmoil that comes with losing your ability to earn an income.
Insuring against a loss of your human capital is formally known as income protection and involves taking out a long-term insurance policy against your ability to earn an income. If something happens to you (such as illness or disability) such that you can no longer work, your income protection policy will pay you a monthly income.
If you are fortunate enough to belong to an employee benefits (EB) scheme, income protection is usually included alongside your medical, life, and disability cover. If you become incapacitated, the insurer would effectively pay a percentage of your salary until you were declared fit to work again (if you were unable to work temporarily), or you reached your pre-selected retirement age (if you were unable to work permanently).
Standard income protection pays out between 50 — 75% of your net salary, free from tax. This can be increased or decreased either in your personal capacity, or through your EB scheme if it offers such flexibility. If you don’t belong to an EB scheme, income protection must be taken out in your personal capacity with a life insurer of your choice.
Be mindful of what partial income protection could mean. Continuing with our example from before, assume that our hypothetical 40-year old has income protection that will pay out 75% of her current salary. She falls foul of a mental illness and can no longer work. Her insurance company, satisfied with her diagnosis, would then pay her R30,000 a month (R40,000 x 0.75). The loss of R10,000 per month would force her to reduce her cost of living, especially if she plans on maintaining her contributions to her all-important retirement plan.
When taking out income protection, you also need to be aware that most insurers will not cover pre-existing conditions. So, if you suffer from depression and you have an episode, they are unlikely to provide an income while you get back on your feet. Combing the fine print in your policy for these types of exclusions is a tedious but necessary exercise.
Other things to look out for are waiting periods (known as ‘deferral periods’) that delay the commencement of your income protection payments and the rate at which your monthly income protection claims escalates per year — at the very least, make sure they keep pace with inflation. Lastly, income protection can be stipulated on an ‘own occupation’ or ‘any occupation’ basis. The former pays out if you are not able to meet the demands of your current job, whereas the latter will only pay out if you cannot perform any work at all.
Income protection pays you a monthly amount equal to a percentage of your salary. Lump sum disability cover pays out a once-off chunk of money that can be used to pay off debt to reduce your expenses, or invested to provide a replacement for the income you can no longer earn.
The major difference between these two options is that with a lump sum payout, you are then responsible for investing that money in such a way that the returns will be sufficient to meet your expenditure needs. With access to the entire lump sum, you’ll also need to be more disciplined. Income protection and lump sum disability cover can be used in parallel to each other.
Insurance products, including income protection, are intricate by nature. It is, therefore, recommended that you seek advice from your wealth manager before self-selecting an option. They can help tailor a solution that is cost effective and provides the right income protection given your specific set of circumstances.
Paying for income protection, like any form of insurance, is done begrudgingly. But unlike losing a house or a car which you could work to replace, losing the ability to earn a living may be irreversible, leaving you largely powerless to forge your own destiny. On its own, that reality will be very difficult to digest.
What will make the pending challenges easier to face is knowing that an income will be provided, that you won’t have to sacrifice your standard of living, that you won’t become a burden on your family, or anyone else. That peace of mind is priceless and can be achieved through income protection.